Sunday, 28 November 2010

Watching the Decline

Since November 1st, I’ve been shuttling back and forth to Cyprus for a consulting project. From this vantage point, I’ve been able to monitor the remarkable decline of Greek political and economic fortunes from a more remote and objective viewpoint. The events of this past month have been staggering:

·On November 14th, the second round of local and regional elections took place. It would seem that the lessons of the financial crisis have not been learned, since these elections proceeded in much the same way as those before, driven by personalities or party affiliations, without any practical plans or budgets on offer. Five of the six parties running differentiated themselves as being “anti-Memorandum”, as though their “resistance” against an act of Parliament was relevant, and as though our European creditors would be amused to learn that the legal conditionality of their bail-out loan to Greece was now being challenged, at least in the court of public opinion.

·The elections themselves were carried out again the backdrop of a magnificent blackmail by the Prime Minister: “Vote PASOK, or I will call national elections.” Again, our European creditors were hardly amused—Papandreou backed down on the evening of the first round, claiming, somewhat weakly, that the results in the first round provided enough support. In any event, it would not seem that the voters themselves were convinced, since over 50% of them stayed home or cast a white ballot.

·The elections themselves were prefaced by PASOK engaging in pre-election maneuvers of the worse kind. ERT announced the hiring of 640 staff (perhaps ERT’s 5 orchestras needed more trombone players); the Prefecture of Pireaus hired 67 workers; a range of other organisations announced or implemented last-minute hires.

·On November 15th, Eurostat published its revised and final (they claim) estimate of Greece’s 2009 deficit. This included the addition of EUR 18 billion is semi-governmental organisation debt to the central government’s books, driving the deficit to 15.4% GDP, and total debt to 126.8% GDP. As predicted, the government deficits from 2006-2009 were increased as well. As the government’s 2011 draft budget succinctly states:

From EUR 168 billion in 2003, the total debt grew to EUR 298 bln in 2009, an increase of EUR 130 bln.

This debt level is obscene, and the fact that most of it occurred during the Karamanlis government’s 6 years in power is regrettable.

·On November 18th, the government announced its 2011 draft budget. Given the deteriorating financial situation, the budget calls for a massive fiscal adjustment. With the 2010 deficit estimated at 9.4% GDP, the 2011 target has been set at 7.4% GDP, and 6.5% in 2012

·On November 21st, Dora Bakoyianni launched her new, centre-right political party, “Democratic Alliance”. Its platform calls for a number of interesting policies, including a 20% flat tax, but makes no reference to how these will contribute to solving the debt crisis. Given Bakoyianni’s own record as Mayor of Athens, it is difficult to see how credible her calls are for transparency in the public sector, but this is not a problem unique to this politician or this political party.

·Her political launch led to the expected paroxysms in Antony Samaras’ New Democracy, including the expulsion of one MP, and it would now appear that, following the left, the right will splinter as well. For all the good the right has been doing recently, I can’t say this outcome is the wrong one.

·These events have led the government to announce a panic-ridden search for additional sources of expenditure cuts and revenue increases. Unfortunately, it is difficult to see how this will happen given the implementation record to date, and when Ministers such as Louka Katseli or Dimitris Reppas continue to pander to the unionised public sector.

But these facts, dismal though they are, regrettably confirm the longer-term trend:

a.Greece’s public debt at end-2009 starts at EUR 298 bln, but the deficit target set out in the 2010 estimate and 2011 budget is based on each government component meeting its targets. So far, this has not been happening. Social security funds, hospital debts, and the debt of other entities such as the Hellenic Railways Organisation or the Agriculture Insurance Funds continue to rise. The government itself manifests a cash flow debt of at least EUR 7 bln, which until now has been met by payment delays and delays in VAT reimbursements.

b.The major problem affecting Greece is not necessarily the public debt, but four far more serious, systemic “debts”:

·The lack of political will among Greece’s political elite, and even within the governing party, to implement painful yet necessary reforms.

·The lack of a competent, value-driven civil service capable of right-sizing itself and developing a meritocratic approach.

·The lack of a comprehensive approach towards reducing corruption and prosecuting past instances of corruption. The fact that major cases such as Siemens, Skaramanga, MAN, Vatopedi, hospital procurement, military procurement, and many other cases remain unresolved or even unprosecuted is an insult not just to Greek taxpayers, but to our European creditors, who are increasingly wondering whether they should pay for the orgy of crime which has occurred for years, and apparently continues.

·The fact that the Greek professional and commercial classes continue to avoid paying their fair tax assessments, while making increasing use of standard tax avoidance (e.g. by not reporting income), or “legal” tax avoidance, using offshore structures.

c.The micro- and macro-economic environment against which Greece is making its reforms appears to be almost ignored. We are working in an environment characterised by three major trends:

·The long-term trend of declining international competitiveness, both within Greece, but also within the EU. In this environment, Asian producers are increasingly winning market and value share, and climbing the innovation ladder. Greek and wider European producers, in contrast, rely excessively on protected markets or subsidy schemes, most of which nurture sunset industries such as agriculture or cotton textiles, while penalising (through regressive tax systems) future industries.

·The fact that we are not fighting against the deflation of one bubble, but two. The first bubble is the high sovereign debt issues which characterised most countries in the past 10 years, and which are regrettably set to continue into the future. The second bubble is the fact that nearly every sector in Greece (and Europe) is characterised by massive overcapacity, at a very time when public and private sector consumption must fall to balance excessive debt. Much of this overcapacity is value-destroying (based on sunset or protected industries) rather than value-creating, or is based on the import of Asian products (textiles & garments, electronics).

·The fact that the primacy of the state as a means of development is still followed avidly in Europe, and particularly in Greece. This is despite the fact that state spending in Greece has crowded out and distorted (through corruption, regulation and subsidies), private sector investment, and created much of the overcapacity mentioned. Until the dead hand of the state relinquishes its rigor mortis grip, we cannot expect serious economic development, i.e. development based on commercial viability rather than government subsidies, protectionism or crony capitalism.

I believe that the changes sought by the PASOK government are necessary. But I also believe they are doomed to fail. Neither the Greek political system nor Greek society appears aware that they are operating in a deeper, wider, global economy characterised by a fundamental paradigm shift in competitiveness, demography and debt. The Greek budget forecasts, while an improvement over previous years, suffer a massive credibility deficit and implementation risks, not to mention further hidden system debt. And all the time, the interest on EUR 340+ billion public debt keeps rising, while the threat of default looms as it is highly unlikely the markets will be prepared to resume lending to Greece by 2013 at the levels needed to refinance its debt.

We should therefore see the situation as it really is, rather than as we would like it to be, and prepare for the inevitable. In this case, we should prepare for the worse.

Yes, that would be Scenario C. Although the latest announcement on extending the EUR 110 bln bail-out is excellent news - one of the greatest threat to the package was the early need to repay EUR 146 bln in 2013-2014.

I'm still not sure the markets will be ready or willing to lend by then, but let's see. At least we are talking slightly more logical numbers.

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